MarketView for December 16

Summary

After rising sharply at the opening bell, the major equity indexes began to lose ground shortly after the Fed released its statement at the close of a two day meeting. The Fed reminded investors that it would start to wean the economy from an array of emergency supports next year. Wall Street knew several of the programs would be dismantled next year, but policymakers hadn't confirmed the precise timing.

The prospect of an eventual increase in interest rates and an improving economy pulled the dollar off its lows of the day. The dollar has been sliding for most of nine months but reached a two-month high on Tuesday. As the dollar pared its losses in afternoon trading, stocks began to lose steam.

The Street loses no time in parsing Fed statements to see how policymakers are viewing the economy and for clues about when the central bank might raise interest rates. Ultra-low borrowing costs have pushed stocks higher this year and helped weaken the dollar.

Stocks were higher ahead of the Fed's announcement primarily because a benign reading on consumer price inflation eased concerns that the Fed would be forced to raise interest rates any time soon. The statement from the central bank reinforced that notion. The Fed repeated that inflation is likely to remain under control and that interest rates would remain low for "an extended period."

The government reported that consumer prices excluding food and energy were flat in November, signaling that inflation isn't working its way into the economy. It was the first time that "core" inflation was unchanged after 10 monthly increases. Stocks fell for the first time in five days on Tuesday as prices at the wholesale level jumped.

Bond prices mostly fell, pushing yields higher, following the Fed's more upbeat assessment of the economy. The yield on the benchmark 10-year Treasury note rose to 3.61 percent from 3.60 percent late Tuesday. Prices had been higher ahead of the Fed's announcement.

Fed Says Status Quo Remains Unchanged

As expected, the Federal Reserve voiced guarded optimism that the battered job market was improving. However, at the same time the Fed made it clear that it planned to keep interest rates extraordinarily low for "an extended period." In a unanimous decision, the Fe left benchmark overnight rates on hold in a zero to 0.25 percent range, and underscored the economy's improvement by saying it would shut down most of its emergency lending facilities as scheduled on February 1.

Outlining its thinking, the Fed highlighted signs showing the economy's recovery from its deepest recession since the 1930s was gaining strength in a statement released after a two-day meeting.

"Economic activity has continued to pick up ... the deterioration in the labor market is abating," it said.

With the economy expanding again, investors are wondering when and how quickly the Fed will begin to wind things down. That day of reckoning appeared a small step closer given the central bank's acknowledgment that the outlook was improving. Still, the Fed made clear it was in no rush to raise rates due to the weakness of the labor market and lack of an immediate inflation threat.

"Economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period," the central bank said.

A string of recent reports has indicated the economic recovery may prove stronger than many had expected as recently as a few weeks ago. Industrial production, which fell off a cliff when credit markets seized in late 2008, has started to crawl its way out of the hole, consumer spending has shown surprising resilience and the pace of job losses has slowed sharply.

Still, with unemployment at 10 percent, Fed Chairman Ben Bernanke has come under fire for failing to spot the financial crisis ahead of time and focusing rescue efforts too narrowly on the banks. The Senate Banking Committee is set to vote on Bernanke's nomination for a second term on Thursday. While it is widely expected to recommend that the full Senate approve it, many lawmakers have been vocally critical.

On Wednesday, Bernanke earned some reprieve as Time Magazine said it had named him "Person of the Year.

Core CPI Unchanged

The Labor Department reported Wednesday morning, prior to the opening bell that its consumer price index rose 0.4 percent in November after a 0.3 percent gain in October, pushed up by a strong increase in energy costs. However if you exclude the volatile food and energy sector, prices were flat, thereby putting somewhat of a halt to the worries Wall Street had over a possible outbreak of inflation.

A sharp rise in prices at the producer level in November had fanned speculation the Federal Reserve would soon be forced to shift away from its pledge to keep interest rates exceptionally low for an "extended period." Over the last 12 months, consumer prices have risen 1.8 percent, the first year-over-year gain since February.

The fairly benign consumer price report and the Fed's commitment to low interest rates helped to raise stock prices, while short-term interest rate futures rose as traders bet the Fed would hold rates near zero longer than initially anticipated.

While the consumer price report showed inflation pressures are largely contained, the downward pressure on prices the Fed sought to combat with its sharp interest rate cuts has abated.

A drop in rental costs last month offset gains in prices for vehicles, medical care and airline fares to keep the so-called core CPI, which strips out food and energy costs, unexpectedly flat when compared with October. High vacancy rates, coupled with problems in the commercial property market, should continue to weigh on rental prices, helping to keep a lid on inflation pressures.

On a year-over-year basis, core inflation slowed to a 1.7 percent gain in the period through November from the 1.8 percent rise in the 12 months through October.

Housing Starts Rise

The Commerce Department reported on Wednesday that housing starts rose 8.9 percent to a 574,000 unit annual rate last month, a solid gain but slightly below market expectations, suggesting a recovery in housing was on track.

While home construction bounced back in November, groundbreaking for single-family dwellings -- the largest segment of the housing market -- was less robust.

Starts for single-family homes rose 2.1 percent to an annual rate of 482,000 units, failing to fully reverse the prior month's sharp drop. rose 6 percent to 584,000 units last month, the highest since November 2008.

Construction starts for the volatile multifamily housing sector surged 67.3 percent to a 92,000 annual pace, reversing the previous month's plunge. However, analysts were encouraged by a strong rise in permits for future building activity. The inventory of all homes under construction fell 3.2 percent to a record low of 540,000 units in November.